I warned many about the coming crisis, long before it happened, on many occasions and in many places, even at the World Bank. They did not want to listen and that´s ok, it usually happens, but what is not ok, is that they still do not seem to want to hear it. “We can easily forgive a child who is afraid of the dark; the real tragedy of life is when men are afraid of the light.” (Plato: 427 BC – 347 BC)

We also read some estimates of that Barclays’ would have to lose about $16bn in capital before falling under the 7% trigger.

But, losing capital is not the only way this sort of trigger can be pulled in a risk-weighted world. Suppose Barclays’ management, next month, brings to the board the following proposal which includes an important shift of bank assets:

Management proposal to the Board of Director of Barclays

Friends, you know that one of the very few possibilities our dear Britain has to pull out of its current doldrums is to allow the small businesses and entrepreneurs to help out more. And in this respect we have now decided to try to do our part and sell a substantial amount of our UK government debt and instead invest these funds aggressively in small and well analyzed loans to our more risky daring and risk-taking community.

But, and here is the question, since UK government debt carries a risk-weight of zero and these small businesses and entrepreneurs have a risk-weight of 100% doing the above would cause our Common Equity Tier 1 ratio to fall below 7% and therefore trigger what converts into a zero liability our recent contingent capital notes issue. What are we to do?

The bondholders would clearly hate it but from the perspective of the shareholders this would imply an immediate very real profit of $3bn that, though we have to sort out the tax implications, can undoubtedly come in real handy. On a side note we are also checking on whether this extraordinary liability write down profit signifies having to pay higher bonuses to those who brought us the contingent capital notes’ deal.

An alternative we are also exploring is to see if the regulators, even if on a just a short term basis, would increase somewhat the risk-weights on all what is currently weighted between zero to and 20 percent. For instance a risk weigh of only 10 percent on UK public debt would probably suffice to trigger. For anyone of you who could worry about what that would mean to our UK public debt exposure, that would still mean we need to hold less than 1 percent in capital against UK public debt, which means that we could still leverage our capital more than a hundred times with UK public debt. Unfortunately, our first contacts with regulators about this possibility have not been very productive. It seems they feel a bit uncomfortable with the idea of them taking the blame for the fall of the bondholders.

We leave now this decision entirely in your hands though of course it is an appropriate moment to remind all that we owe ourselves primarily to our nation and our shareholders and of the fact that we are paying a not so insignificant coupon of 7.625% on those notes.

Monday, November 26, 2012

Currently, by your actions, you clearly respond “Yes!” to that question.

The fact is that with your capital requirements for banks based on perceived risks, you make the access to bank credit for an unrated small business, much more difficult and expensive than what it would otherwise be, and that of a triple-A rated company, one of yours "The Infallible", so much easier and cheaper than what it would also otherwise be.

It just makes no sense and completely distorts the economic resource allocation function of our banks.

It is “The Risky”, small businesses and entrepreneurs who are most in need of access to bank credit on fair market terms, and it is also they who stand the greatest chance of coming up with the next generations of jobs.

Also, why does a bank have to have more capital when lending to a small business that creates a private sector job than when lending to a government in order to create a public sector job?

Mr. Bank Regulator, if I was a young European with poor future employment prospects, I would be kicking your but, as much as I could. Your regulatory discrimination in favor of “The Infallible” and against “The Risky” is just too odious.

Sunday, November 25, 2012

Daron Acemoglu and James A. Robinson have written an interesting book titled “Why Nations Fail”. In it they detail the importance of having adequate economic institutions and of creating incentives that rewards innovation and allows everyone to participate in economic opportunities.

To my surprise though, the importance of the willingness to take risks, is not mentioned.

Bank regulators, about a decade ago, with Basel II, out of the blue, authorized by I don’t know who, suddenly decided that our banks should take less risks than usual, and allowed the banks to hold much lower capital when exposed to assets perceived as “The Infallible” than when holding “The Risky”.

That meant that banks would be able to earn immensely higher expected risk adjusted returns on their equity when lending to “The Infallible” than when lending to “The Risky”.

That meant that our bank regulators effectively locked out “The Risky”, like small businesses and entrepreneurs from having access to bank credit on equal terms.

And that also meant the bank regulators doomed our banks to end up overexposed and holding too little capital to assets that though they ex-ante could qualify as “The Infallible” got too much access to bank credit, on too generous terms, and therefore, ex-post, turned into extremely risky assets.

And I know for sure, that when a nation starts worrying more about its “History”, “What It Has Got”, “The Infallible”, “The Old”, than about its “Future”, “What It Can Get”, “The Risky”, “The Young”, it will stall and fall… no doubt about that. Risk-taking is the oxygen of any economic development.

And now our bank regulators are even doubling down on their mistakes. Basel III will not only conserve the capital requirements based on perceived risk, it will now also have liquidity requirements based on perceived risks.

Come on, Europe, America (Home of the Brave)… what happened to our “God make us daring” that we used to pray for in our churches?

Sunday, November 18, 2012

“Several years before the financial crisis descended on us, I put forward the concept of "black swans": large events that are both unexpected and highly consequential. We never see black swans coming, but when they do arrive, they profoundly shape our world…. Still, through some mental bias, people think in hindsight that they "sort of" considered the possibility of such events; this gives them confidence in continuing to formulate predictions”

And so Nassim Taleb still provides the failed bank regulators with the comfort of this being an unforeseeable crisis. Boy how much they must adore him and his black swan.

When regulators allowed the banks to hold immensely less capital for exposures considered as not risky, “The Infallible”, than for exposures considered “The Risky”, they virtually doomed the banks to originate dangerously excessive exposures to “The Infallible”, precisely the kind of exposures that have always detonated major crisis when, ex-post, most often because they are too much financed, turn out, ex-post, as very risky…. like the triple-A rated securities backed with lousily awarded mortgages to the subprime sector, like Greece, like Spanish real estate…

And by the way there is nothing much new in the concepts in “Learning to love volatility” or “Anti-fragility”, they represent precisely what we mean when praying in our churches “God make us daring!”

When you restructure a company that has gotten itself into financial problems, you do not inject new funds before you have made the structural changes that allow you to reasonably expect that the company will recover, and so that you are not just throwing good money after bad.

Unfortunately there has been no fundamental or significant restructuring carried out at all during the current crisis. And that is because so many bought into the fallacy of this crisis being caused by a “black swan” event, one which no one could foresee, and which therefore needed not to happen again. Bank regulators have of course been especially fond of this concept, as it reinforces their innocence.

But no! This was no black swan event. When regulators allowed the banks to hold immensely less capital for exposures considered as not risky, “The Infallible”, than for exposure considered “The Risky”, they virtually doomed the banks to originate dangerously excessive exposures to “The Infallible”, precisely the kind of exposures that have always detonated major crisis when, ex-post, these appear as very risky…. like triple-A rated securities backed with lousily awarded mortgages to the subprime sector, like Greece, like Spanish real estate…

And so all bail outs, fiscal stimulus and quantitative easing done, without any fundamental structural change, like eliminating the capital requirements for banks which discriminate based on perceived risks, have just wasted preciously scarce fiscal and monetary policy space.

When are our governments to wake up to the fact that those who messed it up were the not so white white-regulator-swans? And to the fact that the Basel regulatory paradigm is silly and sissy and must be thrown out the window... urgently?

Saturday, November 17, 2012

Current capital requirements for banks, based on perceived risks, allow banks to expect to earn much more risk and transaction cost adjusted returns on equity when lending to “The Infallible”, than when lending to “The Risky”.

And therefore, the already dangerous huge exposures of banks to “The Infallible” or to “The Infallible” who morphed into being risky are growing day by day, while the exposures to those originally perceived as “The Risky”, like small business and entrepreneurs, are, equally or even more dangerously for the economy, drying up.

And, as bank capital gets scarcer and scarcer, the de-facto discrimination in favor of “The Infallible” and against “The Risky” increases. And now, with regulators doubling down on their mistake and also creating liquidity requirements based on perceived risk, it will all just get worse.

Day by day “The Infallible” needs to pay lower interest rates, and “The Risky” higher ones, than what would have been the case without the distortions imposed by the regulators, or, as The Joker would call them The “Schemers”.

We must urgently put a stop to this. Not only do our best chances of revitalizing economic growth rates lie in giving “The Risky” equal access to bank credit, but also we need to give our small savers, our widows and orphans and our pension funds, an equal opportunity to save with exposures to “The Infallible” that produce the returns they should produce.

Therefore regulators, please…..temporarily lower the capital requirements for banks on exposures to “The Risky” and draw up a schedule for over some few years, making the capital requirements to be the same for the exposures to “The Infallible” and to “The Risky”.

In fact since “The Risky” have never ever caused a major bank crisis and these have always, no exceptions resulted from excessive exposures to “The Infallible” that turned risky, if you schemers cannot refrain yourself from interfering and distorting, perhaps to feel you earn your salary, then why do you not set the capital requirements for banks slightly higher on exposures to “The Infallible” than on exposures to “The Risky”. That would make much more empirical sense, you dummkopfs!

And you congressmen, please come up fast with some good tax incentives for those who inject fresh capital into our banks and that is so much needed.

But, when regulators allow banks to hold much less capital when lending to “The Infallible" than when lending to “The Risky”, then the banks will be able to earn a much higher risk-adjusted return on their equity lending to The Infallible than when lending to “The Risky”.

And so then “The Infallible” will be charged even lower interest rates, get even larger loans and on even easier terms, while “The Risky”, like our not-so-good rated or unrated small business and entrepreneurs, will be charged even higher interest rates, get even smaller loans and have to accept even stricter terms.

And so let me ask you, do you really think this regulatory discrimination in favor of The Infallible and against The Risky makes an economic sense that might compensate for its injustice? I don’t, quite the opposite!

It is outright foolish from an economic perspective, as it impedes banks to allocate our economic resources efficiently. And, to top it up, it brings more instability to the banking system because the bank exposures to what is ex-ante perceived as part of “The Infallible”, which are the only exposures that can set of a systemic crisis if ex-post these turn out to belong to “The Risky”, will not only be much higher but the banks will also be receiving the blows holding much less capital.

In truth bank regulators castrated our banks, and so these are all singing in falsetto now… and even badly so.

Frankly, between you and me, if I really thought the regulators had concocted these dumb regulations which are destroying our economies and causing so much suffering, knowingly and on purpose, I would consider that to be an act of high treason, and suggest they be shot, on the spot.

Tuesday, November 13, 2012

This economy did not collapse because of lack of stimulus, it collapsed because of bad regulations that gave banks too big incentives to acquire huge exposures with some of “The Infallible”, helping to make the not-risky risky, and by banks not wanting to hold exposures to “The Risky”, like to small businesses and entrepreneurs.

And since those basic bank regulation principles have not yet been changed one iota, I simply do not understand why any sort of stimulus package should be able to turn around the economy in a sustainable way, and that is why I find the whole discussions in the US about the fiscal cliff, although interesting quite irrelevant.

And this cliff debate also makes me remember some politician somewhere gloriously stating: “We are standing in front of the precipice; it is time to take a big step forward”.

I suppose you are all professional with solid academic degrees and a lot of knowledge and experience rating the creditworthiness of borrowers. If not, excuse me and ignore the following question.

You must be aware of course that bank regulators allow the banks to hold much less capital when investing in an asset that has been deemed to you as belonging to the privileged group of “The Infallible” than when holding an exposure to something less well rated or unrated.

And you must be aware of course that this allows banks to expect to earn much higher much higher risk-adjusted returns on their equity when lending to “The Infallible” than when lending to “The Risky”.

And of course you must understand that this means than banks will invest more and more in assets considered to be part of “The Infallible” and less and less to assets considered “The Risky”, like small businesses and entrepreneurs.

And so here is my question to you: With banks that are given special regulatory subsidies to invest, almost exclusively, in “The Infallible” and abandon, almost totally, the lending to “The Risky”, in a competitive world, can any country keep a healthy economy that allows it to service its long term debt at current levels of public debt? Is not a very important degree of risk-taking by banks a must to keep economies rolling?

I know what the extreme importance given by the regulators to your credit ratings has done to your business… but, come on, frankly, is that just not something too risky for the world you want to hand over to your children and grandchildren?

Saturday, November 10, 2012

There can hardly be a more insidious way to destroy a nation than to make its banking system more risk averse than what it normally is.

And that our current bank regulators did, unwittingly, with Basel II, when they allowed the banks to hold so much less capital when lending to “The Infallible” than when lending to “The Risky”… and therefore to be able to earn so much more return on their equity when lending to “The Infallible” than when lending to “The Risky”… and therefore also to be able to pay the bankers so much higher bonuses when lending to “The Infallible” than when lending to “The Risky”. Doing so the regulators effectively "bribed" the banks to lend only to “The Infallible” and to abandon all bank lending to “The Risky”.

And that, of course, caused the bank exposures to “The Infallible”, those ex-ante perceived as absolutely not risky, precisely those to whom excessive lending has always caused all major bank crisis when they, ex-post, turn out to be “The Risky”, to explode as never before.

Just one piece of evidence: Basel II, approved by G10 in June 2004, allowed the banks to lend to a sovereign rated like Greece holding only 1.6 percent of quite loosely defined bank capital (equity) while, if lending to a Greek small business or entrepreneur, they needed to hold 8 percent in capital. That allowed the banks to leverage their capital 62.5 times when lending to the Greek sovereign but only 12.5 times when lending to a Greek small business or entrepreneur. That, if the bank could make a net risk and cost adjusted margin of 1 percent when lending to either the sovereign the small business or the entrepreneur, meant the bank could expect to earn 62.5 percent on capital per year when lending to the Greek sovereign, compared to only 12.5 percent when lending to a Greek small business or entrepreneur.

And of course the Greek sovereign received too much bank loans. And of course the Greek small business and entrepreneur received too little bank loans.

And now when the Greek sovereign, as s direct result of this is in the absolute doldrums it cannot receive any more loans from banks, and Greek small businesses and entrepreneurs, those Greece most need to help it out of its current predicaments, are completely locked out from access to bank credit.

I tell you, if I thought bank regulators had done this on purpose, to Greece, Europe and America, I would suggest shooting them… no doubt.

But what I cannot comprehend is how we can allow regulators who unwittingly were so dumb, to keep on regulating, to give us Basel III, which, with now also liquidity requirements based on ex-ante perceived risk, can only make it all so much worse.

A nation is built and thrives on risk-taking. “God make us daring!” The moment the past, what has been built, “The Infallible”, becomes more valuable to its society than the future, what can be built, “The Risky”, and excessive risk adverseness sets in, the nation stalls and falls. It is as simple as that.

Friday, November 9, 2012

We are fed up with you getting into so much trouble, and us being blamed for it. Therefore, and as we know that incentives matters, we will allow you, with our Basel II regulations, to hold much less capital when you do lending or investing business with those our expert consultants the credit rating agencies consider as The infallible, than when you do business with The Risky.

Since that will allow you to obtain immensely higher returns on equity than what is usual in banking, and so be able to pay yourself much higher bonuses, we are sure to count on your full cooperation.

Yours sincerely,

The Bank Regulator, of the Basel Committee for Banking Supervision

2nd letter

America and Europe, June 2004

Dear Bank Regulator

Many thanks for Basel II!

You can sure count with our fullest cooperation implementing it and in fact we already started to anxiously look around for (and some of use even create) AAA rated business.

Yours sincerely,

The Bankers; mostly on behalf of the larger soon to be even larger banks

3rd letter

Washington, June 2004

Dear Bank Regulator

On behalf of my former and future clients, the not-so-good rated and unrated small businesses and entrepreneurs everywhere, “The Risky”, let me express my deepest concern with the Basel II you have just enacted.

The pillar of those regulations is that banks will be able to hold much less capital when doing banking business with “The Infallible” than when doing so with “The Risky”. That means, of course, that banks will obtain much higher comparative risk adjusted returns on their equity when doing business with “The Infallible” than when doing business with “The Risky”. And that, pardon my sincerity, I find to be both stupid and obnoxious.

First, my clients, “The Risky”, because bankers always tend to be very careful when doing business with them, have never ever caused a bank crisis. On the contrary, since all major bank crises have always resulted from excessive bank exposure to what was thought to be a member of “The Infallible”, your regulations will only guarantee that the resulting bank crises will be even larger than major.

Second, the fact that those ex-ante considered as “The Infallible” will be treated so favorably, increases the chances of them becoming, ex post, “The Risky”; and with that that banks will find themselves standing naked with no capital at all in the midst of the next major crisis.

Third, since credit raters are human, there is an immense danger in giving excessive credence to credit rating agencies, as for them being able to determine with sustainable preciseness who are “The Infallible” and who are “The Risky”.

Fourth and most importantly, let me remind you that “The Infallible” of today have almost always been “The Risky” of yesterday and so, if you persists in regulations that favor those who built the past and discriminate against those building the future, you must understand that for a more systemic and larger trouble than ordinary bank troubles... and that no bank can survive standing in the middle of the rubble of huge economic descent.

Yours sincerely,

Per Kurowski

An Executive Director of the World Bank (mind you, only one of 24)

Monday, November 5, 2012

From November 2002 through October 2004, I was one of the 24 Executive Directors (EDs) on the Board of the World Bank. And those were the years when bank regulations known as Basel II and which were approved in June 2004 were much discussed. And I was totally set against these.

Already in November 1999 in an Op-Ed titled “The SEC, the human factor, and laughing” I had written “The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause the collapse, of the only remaining bank in the world”

In February 2000, in an Op-Ed titled “Kafka and global markets" I warned about the following risks with global bank regulations:

1. A diminished diversification of risk: No matter what bank regulators can invent to guarantee the diversification of risks in each individual bank, there is no doubt in my mind that less institutions means less baskets in which to put one’s eggs. One often reads that during the first four years of the 1930’s decade in the U.S.A., a total of 9,000 banks went under. One can easily ask what would have happened to the U.S.A. if there had been only one big bank at that time.

2. The risk of regulation: In the past there were many countries and many forms of regulation. Today, norms and regulation are haughtily put into place that transcend borders and are applicable worldwide without considering that the after effects of any mistake could be explosive.

3. Excessive similitude:By trying to insure that all banks adopt the same rules and norms as established in Basel, we are also pushing them into coming ever closer and closer to each other in their way of conducting business. Unfortunately, however, nor are all countries the same, nor are all economies alike. This means that some countries and economies necessarily will end up with banking systems that do not adapt to their individual needs.

4. The cost of global assistance: When Venezuela’s banking system went down the drain, there is no doubt that the cost of the crisis was paid integrally by the country itself. In today’s world, when we see that a series of international banks are investing in our country’s institutions, I often wonder what will happen when one of these behemoths runs into serious trouble in its own country. Will we have to pay for our part of the crisis, less than our part of the crisis or more than our part of the crisis?

In July 2002, firmly believing that risk-taking is the oxygen of development I was especially critic of Basel Bank regulations when applied in a developing country, as this quote, from an Op-Ed titled “Our economic policies suffer an inferiority complex” shows: “Our country has adopted, without blinking an eye, the regulations coming out of the Basel Committee, that are more appropriate for the banking sector of a developed country than for ours. There is nothing wrong being a developing country, the bad is only to believe that by just adopting different postures, one could reach a different degree of maturity… just like the little girl who borrows mother´s lipstick in order to feel big.”

And in September 2002, in an Op-Ed titled “The riskiness of country risk” I wrote the following: “If they underestimate the risk of a given country, the latter will most assuredly be inundated with fresh loans and will be leveraged to the hilt. The result will be a serious wave of adjustments sometime down the line. If on the contrary, they exaggerate the country’s risk level, it can only result in a reduction in the market value of the national debt, increasing interest expense and making access to international financial markets difficult. The initial mistake will unfortunately turn out to be true, a self-fulfilling prophecy.”

And so, even though I had never been a regulator, or a full-fledged banker, you can understand what was in my mind when I took up my duties as an ED. And, through my full two years I did as much as I could to express, in all shapes of forms, what I felt was wrong with the regulatory paradigm imposed by the Basel Committee for Banking Supervision.

Most of my more technical objections were expressed in the Audit Committee of the World Bank, of which I was a member, certainly the most vociferous one. I have no formal records of these meetings but any other ED member of that Committee or the WB staff who assisted should be able to attest my constant warnings about “counter-party risks” and about the AAA-bomb that was doomed to explode in the midst of our banking system. (I never knew specifically what AAA rating would explode, where and when, but I was certain one would)

But outside of that Committee I also spoke out and on this many records exist:

In January 2003 I finished a letter that the Financial Times published with “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds”

“In this otherwise very complete report there is no mention about the issue of the growing role of the Independent Credit Rating Agencies, and the systemic risks that might so be induced, when they are called to intervene and direct more and more the world’s capital flows.

It is not a small issue. Today many insurance companies and pension funds are already limited by the credit ratings for their investments and, for banks we are only told things will get worse.

The sole fact that emerging countries, when affected by lower credit ratings, face additional difficulties to access investors with availability of long term financing, forces them into more short term arrangements which, compounded by the much higher rates charged, almost guarantee a crisis, once the snowball starts rolling.

The document does not analyze at all a very fundamental risk for the whole issue of Development Finance, being it that the whole regulatory framework coming out of the BCBS might possibly put a lid on development finance, as a result of being more biased in favor of safety of deposits as compared to the need for growth.

As the financial sector grows ever more sophisticated, making it less and less transparent and more difficult to understand for ordinary human beings, like EDs, it is of extreme importance that the World Bank remains prudently skeptical and vigilant, and not be carried away by the glamour of sophistication. In this particular sense, we truly believe that the World Bank has a role to play that is much more important than providing knowledge per-se and that is the role of looking on how to supply the wisdom-of-last-resort.”

And also In March 2003 in a verbal statement as an ED at the board on the Financial Sector Assessment Program I urged the following: “Basel is getting to be a big rule book,” and, to tell you the truth, the sole chance the world has of avoiding the risk that Bank Regulators in Basel, accounting standard boards, and credit-rating agencies will introduce serious and fatal systemic risks into the world is by having an entity like the World Bank stand up to them—instead of rather fatalistically accepting their dictates and duly harmonizing with the International Monetary Fund.”

In April 2003, discussing the World Bank’s Strategic Framework 2004-2006, I again urged: “Basel dictates norms for the banking industry that might be of extreme importance for the world’s economic development. In Basel’s drive to impose more supervision and reduce vulnerabilities, there is a clear need for an external observer of stature to assure that there is an adequate equilibrium between risk-avoidance and the risk-taking needed to sustain growth. Once again, the World Bank seems to be the only suitable existing organization to assume such a role."

In May 2003, in comments made at a workshop for regulators at the World Bank: I said among others: “A regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises. Knowing that “the larger they are, the harder they fall,” if I were regulator, I would be thinking about a progressive tax on size”. Please, if you can read my comments in their entirety

Also in May 2003, in an Op-Ed on Basel bank regulations I warned: “In a world that preaches the worth of the invisible hands of the market, with its millions of mini-regulators, we find it so strange that the Basel Committee delegates, without protest heard, so much responsibility in the hand of so very few and human-fallible credit rating agencies… Perhaps we need to include a label that states: Warning, excessive banking regulations from the Basel Committee can be very dangerous for the development of your country”

And in October 2004, in a written formal statement delivered as an ED at the Board of the World Bank I wrote: “Phrases such as “absolute risk-free arbitrage income opportunities” should be banned in our Knowledge Bank. We believe that much of the world’s financial markets are currently being dangerously overstretched though an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.”

And then finally, in November 2004, having just concluded my term as an ED, in a letter published by the Financial Times I wrote: “Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions it will take before they start realizing the damage they are doing by favoring so much bank lending to the public sector (sovereigns)? In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits. Please, help us get some diversity of thinking to Basel urgently; at the moment it is just a mutual admiration club of firefighters”

Sincerely, how many can like me document having timely warned about the impending AAA-bomb that exploded in 2007?

And now eight years have gone by since I ended my term as an ED of the World Bank. During these years I studied more in depth the Basel bank regulations, something which as an ED I never had time to do, and what I found has just shocked me more. These regulations are utterly dangerous.

I even passed the exams needed to be a licensed real estate and mortgage broker (in Maryland) so as to better understand what happened with the AAA rated subprime debacle. That only confirmed to me my suspicions that what was most to blame were the faulty bank regulations.

Over the years I have refined my arguments keeping active two blogs on the issue; Subprime Regulations and Tea With FT. These blogs jointly have until now received about 140.000 hits, which is not bad for blogs on boring bank regulations which on top of it all do not accept comments, as I have no time to answer these. I had picked out the Financial Times as a channel to give my small voice more volume, but unfortunately I must have trampled on someones ego there or they just do not understand. I have though not given up on FT

And there are even some youtube videos floating around where I try to find the words that will allow me to shatter the current regulatory paradigm that has proved resistant beyond belief.

Given my interest in the issue of bank regulations I also tried, in-numerous times, to qualify for a staff job at the World Bank in the area of financial regulations, but I never made it even to a short-list. I guess c’est la vie!

But what I must confess really upsets or saddens me, especially since the World Bank has a great meaning to me, and I absolutely feel the World Bank should be in the forefront of explaining to the world the importance of risk-taking for development, is that over the years I have assisted to countless conferences at the World Bank on the issue of bank regulations, having had to listen mostly to the same invited speakers over and over again, and never have I been given an opportunity to address directly the World Bank staff with my arguments.

In that respect I have been strictly limited to some interventions in the Q. and A. sessions of such conferences and a 5 minute chance to speak in one of the Civil Society sessions during spring and fall meetings, and this was only the courtesy of a civil society.

And so of course I feel have earned the right to wonder… how comes a “Knowledge Bank”, like the World Bank, can shut out so completely the voice of some who has inside its own walls shown to know and to timely warn?

“The IMF’s ability to correctly identify the mounting risks was hindered by a high degree of groupthink, intellectual capture, a general mindset that a major financial crisis in large advanced economies was unlikely, and inadequate analytical approaches. Weak internal governance, lack of incentives to work across units and raise contrarian views, and a review process that did not “connect the dots” or ensure follow-up also played an important role, while political constraints may have also had some impact.”

Although the many research and articles published by the World Bank points at some incestuous relations, in the case of the World Bank more than groupthink I attribute its failings in discussing bank regulations to group-deafness, most of that resulting from that horrendous “harmonization agreement” signed with the IMF.

And now ten years later than the Global Development Financial Report 2003 that I commented on above, I find that the Global Development Financial Report 2013 only quite meekly comments on the role of “The State as Regulator and Supervisor”, timidly putting forward: “A key challenge of regulations is to better align private incentives with public interest without taxing or subsidizing private risk-taking”; but without getting into what taxes and what subsidies they really refer to.

Well let me give you a very brief summary on what the regulators did in very simple terms.

By allowing the banks to hold much less capital when lending or investing in the “absolutely not risky”, The Infallible”, than when lending to “The Risky”, the small businesses and entrepreneurs, they allowed the banks to obtain much higher risk-adjusted return on equity when financing "The Infallible" than when financing "The Risky". And that translates into a huge regulatory subsidy to "The Infallible" and therefore a huge regulatory tax on "The Risky".

And that:

Guarantees that bank exposures to The Infallible, those who always are the origin of bank crises when their infallibility fails will be higher than ever.

Guarantees that the gap between The Infallible and The Risky will only widen

Guarantees that the safe-havens will become dangerously overpopulated

Guarantees that small businesses and entrepreneurs, will not have an equal opportunity accessing bank credit, and so will therefore not be able to help out as much creating jobs.

World Bank, why have you not yet used your huge voice to ask bank regulators to clearly define the purpose of banks before they regulate these?

It has also been sad for me to see that otherwise splendid "World Development Report 2013: Jobs" not including a word about what I most feel is absolutely necessary to create the next generation of jobs, namely abandoning the unreasonable risk-adverseness that is embedded in the Basel bank regulations.

Really, what is the use of Executive Directors, if their recommendations and warnings can be so blithely ignored by a World Bank that proudly has referred to itself as "The Knowledge Bank"?

Sunday, November 4, 2012

I cannot hold myself to be an expert on American Football, in fact I believe I have never ever thrown or received a real American football, but, that said, I am absolutely sure that any team who concentrated just on defense, would not go far.

And that is what is happening with our banks. The bankers, defensively, consider the perceived risks of default of their clients, when deciding whether to lend or not, how much, at what rates and under what terms. But then came the regulators, and instead of acting as the umpires they should be, they also wanted to be defensive coaches, and used the same perceived risks in order to defensively set the capital requirements for the banks, more risk – more capital, less risk – less capital… and no one really cared one iota about the offensive, namely how banks are to allocate efficiently our economic resources.

And as a consequence, defensive bank plays, like lending to and investing in what is perceived as absolutely safe, “The Infallible”, was made so profitable in terms of return on equity so that these plays, and the defensive players, completely took over the game; while offensive plays, like lending to “The Risky”, like the small businesses and entrepreneurs, and offensive players, like community banks, were completely ignored and abandoned. And, of course, it all lead to disastrous results.

What a lunacy! Head coaches, players, umpires and most of the public are all, like on a ship of fools, still not able to even see what is happening, and many, in “the land of the brave”, begging for even more defensive plays; leaving me and some other few crazy minds all alone in the stands, monotonously shouting: “What about the offensive?”, “What about the jobs?”

Friends, in American Football (and Europe, in soccer too) you can never win if you do not dare to go on the offensive with whatever risks that entails…capisce?

Saturday, November 3, 2012

Even though, those who are perceived as risky, let us, for lack of a better term, call them “The Risky”, get smaller bank loans, must pay higher interest rates, and accept stricter terms, all in line with Mark Twain’s perception of bankers, “he who lends you umbrella when the sun is out and wants it back when it looks it is going to rain”, and have never ever been the cause of a major bank crisis…should they have their access to bank credit made even more difficult by the bank regulators?

Even though, those who are perceived as absolutely not risky, let us, for lack of a better term, call them “The Infallible”, get huge bank loans, ate very low interest rates, and with very soft terms, all in line with Mark Twain’s perception of bankers, “he who lends you umbrella when the sun is out and wants it back when it looks it is going to rain”, and have never ever been the cause of a major bank crisis…should they have their access to bank credit made even more easier by the bank regulators?

If you respond “Yes!” to the two previous questions, you're fine and dandy with what the current bank regulators, like the Basel Committee for Banking Supervision and the Financial Stability Board are doing. If not, you better have a closer look at what’s up. I tell you, you will be surprised and extremely upset.

Thursday, November 1, 2012

When you give someone a favor you are, often unintentionally, de facto, disfavoring the one not receiving that favor.

So when regulators embraced that paradigm that makes the capital requirements for banks a function of ex-ante perceived risks, more risk more capital - less risk less capital, they favored “The Infallible” and disfavored “The Risky”. And that stopped our economies in their tracks.

Because, when you favor access to bank credit for those who are already favored, those who have already made it and do not seem risky, “The Infallible”, and, thereby, additionally disfavor the access to bank credit of those who are already disfavored, those who have not yet made it, “The Risky”, small businesses and entrepreneurs, you are, in essence, subsidizing the past and taxing the future.

But, it gets worse

2nd truth:

When you favor the access to bank credit to someone or somewhat more than what they should normally be able to access it, given their risk-profile, you are, de facto, guaranteeing it will be receiving too much credit and, de facto, sooner or later become extremely risky, no matter how infallible it initially might have been.

Conclusion:

We must get rid of these regulators, they are not wise enough. We can’t afford them! They are completely incapable of taking us out of the hole they dug and placed us in. They will only dig us deeper and deeper into it.

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Why don't bank regulators get it?

The less the perceived risk of default is, and the higher the leverage allowed, the greater the systemic risk.

My huge problem!

Q. "If Kurowski is right, why are his arguments so ignored? A. If I had argued that the regulators were 5 to 10 degrees wrong, I would be recognized, but since I am arguing they are 150 to 180 degrees wrong, I must be ignored.

The deafening noise of the Agendas

The fundamental reasons why it is so hard to advance the otherwise so easy explainable truth of this financial crisis, is because of the deafening noise of the Agendas…

On one side, we have the "progressives" who want to put all the blame on capitalistic banksters, and, on the other, the "conservatives" who want to blame the socialistic government sponsored enterprises GSEs of Fanny Mae and Freddy Mac.

For any of both sides accepting the fact that it was mostly a regulatory failure of monstrous proportions would seemingly be a highly inconvenient truth that would not help them to advance their respective agendas.

You tell me!

What is more dangerous in a systemic way, that which is perceived as risky or that which is perceived as not risky? Right!

How can the Basel Committee be so dumb?

Systemic risks is about something that can become as big so as to threaten the system… and our bank regulators in the Basel Committee are incapable or unwilling to understand that what has the largest possibilities of growing as big so as to threaten the system is what is perceived as having little or no risk, not what is perceived as risky… which makes their first and really only pillar of their regulations, that of capital requirements of banks that are lower when perceived risks are lower… so utterly dumb!

We must stop our gullible and naive financial regulators from believing in never-risk-land.

The stuff that bonuses are made of

Whenever a credit rating corresponds exactly to real underlying risk neither borrower nor lender loses but the intermediary cannot make profits… it is only when the credit ratings are too high or too low that those margins that can generate that profitable stuff that bonuses are paid for exist.

What were they thinking?

The default of a debtor is about the most common, natural and even benign risk in capitalism, so it is so hard to really get a grip on what was going around in the minds of the regulators when they decided to construe capital requirements for banks based exclusively on discriminating against that risk as it was perceived by some credit rating agencies.

Day by the day it is becoming more relevant... scary!

This I published in November 1999... Read it!

The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause the collapse of the OWB (the only bank in the world) or of the last financial dinosaur that survives at that moment.

Currently market forces favors the larger the entity is, be it banks, law firms, auditing firms, brokers, etc. Perhaps one of the things that the authorities could do, in order to diversify risks, is to create a tax on size.”

This I wrote, October 2004, as an Executive Director of the World Bank

We believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.

Regulatory hubris

In a world with so many different risks, some naïve gullible and outright stupid regulators thought everything would be fine and dandy if they just had some few credit rating agencies determine default risks and then gave the banks great incentives, by means of different capital requirements, to follow those credit risk opinions.

On bs.

When experts bs..t the world that’s bad news, but when experts allowed themselves to be bs..ted by bs..ing experts that’s is when the world goes really bad.

My most current proposal on the regulatory reform for banks

Fire the teachers!

They were supposed to teach the world prudent risk-taking and instead they taught it imprudent risk-aversion.

The deal!

This was the deal! If you convinced risky and broke Joe to take a $300.000 mortgage at 11 percent for 30 years and then, with more than a little help from the credit rating agencies, you could convince risk-adverse Fred that this mortgage, repackaged in a securitized version, and rated AAA, was so safe that a six percent return was quite adequate, then you could sell Fred the mortgage for $510.000. This would allow you and your partners in the set-up, to pocket a tidy profit of $210.000

Calling it quits?

A world that taxes risk-taking and subsidizes risk adverseness is a world that seems to want to lie down and die

Let´s neutralize the wimps!

If we are to keep on using Basel methodology for establishing the minimum capital requirements for banks, beside better risk weights, we must demand it also uses “societal purpose” weights.

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Silly bank regulators!

What other word could describe a bank regulatory system designed exclusively to avoid bank crisis as if that is the only purpose of banking. You might just as well order the kids to stay in bed all life so as to diminish the risk of them tripping.

The minimum capital requirements of Basel that are based on default risks as measured by the credit rating agency amount to a dangerous tax on the risk, the oxygen of development.

Blindly focusing on default and leaving out any consideration that a credit with a low default risk but for a totally useless or perhaps even an environmentally dangerous purpose is much more risky for the society than a credit with a higher default risk destined to trying to help create decent jobs or diminish an environmental threat, is just silly.

But do I have to be disrespectful and call them silly? Well, individually perhaps they are not, but, as a group, bank regulators are so full of hot air that someone has to help them to puncture their cocoon balloon and let them out.

Breathe!

I’m going to third-pillar what?

By now the desperate bank regulators are throwing at us the third pillar of their Basel regulations which implies the need that we ourselves privately monitor our banks. Great, in my country, a couple of decades ago, I did just that and had a fairly good grip on whom of my banker neighbors were good bankers and whom to look out for.

But sincerely what am I supposed to do know when about 50 per cent of the retail deposits in my country are in hand of international banks (Spain) and that might be losing their shirt making investments in subprime mortgages in California?

Tragedy!

It is very sad when a developed nation decides making risk-adverseness the primary goal of their banking system and places itself voluntarily on the way down but it is a real tragedy when developing countries copycats it and fall into the trap of calling it quits.

Development rating agencies?

A bank should be more than a mattress!

When considering the role of the commercial banks should not the developing countries use development rating agencies instead of credit rating agencies?

Clearly more important than defending what we have is defending what we want to have.

What do we want from our banks?

Over the last two decades we have seen hundreds if not thousands of research papers, seminars, workshops conferences analyzing how to exorcize the risks out of banking; and if in that sense the bank regulation coming out from Basel was doing its job; and centred around words like soundness, stability, solvency, safeness and other synonyms. Not one of them discussed how the commercial banks were performing their other two traditional functions, namely to help to generate that economic growth that leads to the creation of decent jobs and the distribution of the financial resources into the hands of those capable of doing the most with it.

At this moment when we are suddenly faced with the possibilities that all the bank regulator’s risk adverseness might anyhow have come to naught, before digging deeper in the hole where we find ourselves fighting the risks, is it not time to take a step back and discuss again what it is we really want our commercial banks to do for us? I mean, if it is only to act as a safe mattress for our retail deposits then it would seem that could be taken cared of by authorizing them only to lend to the lender of last resort; but which of course would leave us with what to do about the growth and the distribution of opportunities.

About Me

We are suffering from more and more answers than questions begging for them, and so I work on the latter.
Read it all in my one and only book!"Voice and Noise"
Pssst... so few have read this book so it is slowly turning into a collector item (I do not say a "cult"... yet) and so you might benefit from getting your very own copy now.